The US Dollar Index (DXY) measures the value of the US Dollar against six other major currencies. It recovered from an intraday low of 99.50 to come back close to 99.75. As it happens, the US Dollar is recovering sharply, demonstrating remarkable comeback strength. As the world’s most active traded currency, it remains a constant and ever-powerful force in global foreign exchange markets. On Wednesday afternoon, analysts will be prepared for the Federal Reserve’s monetary policy decision. They are making sure to see how any possible interest rate increases might impact the strength of the US Dollar.
First, the US Dollar enjoys a hegemonic status over the entire global foreign exchange market, accounting for more than 88% of all transactions. In 2022, average daily transaction volume ballooned to a mind-blowing $6.6 trillion. Looking back, the US Dollar became the world’s reserve currency following the end of World War II, deposing the British Pound. The dollar is the official currency of the United States of America. It further functions as the ‘de facto’ currency in many countries, circulating side by side with local notes.
Impact of Chinese Economic Conditions
The latest Flash PMIs indicates a further deceleration in China’s manufacturing PMI. This reversal has created a bearish mood towards currencies directly correlated to China, most notably the Australian Dollar. Australia has outsize stakes in this game—its massive dependence on its exports to China. As such, any indication of economic weakness in Beijing can have outsized effects on the Australian economy. Of course, the US has already raised a hefty 145% import duty on Chinese goods. This unilateral action has disrupted established trade relationships and limited opportunities for American firms looking to engage with Chinese suppliers.
As China continues to tackle issues bringing persistent strain to one of the world’s most dynamic economies, the impacts are felt worldwide. The Australian Dollar, often viewed as a proxy for China’s economic health due to strong trade ties, has felt the pressure. This alarming trend is a reminder of how interconnected our global economy is. Even the slightest fluctuation in one region has the potential to send shockwaves through international markets.
Federal Reserve’s Influence on the US Dollar
On Wednesday, the Federal Reserve will make its next monetary policy decision. This announcement has potential to shake the foundation of the US Dollar. Analysts suggest that if inflation falls below 2% or if unemployment rates remain high, the Fed may consider lowering interest rates. Such a move, if organized well enough, could significantly devalue the US Dollar. Generally, lower interest rates imply lower yields on investments in that currency.
As of writing, the US Dollar has cut most of its intraday losses and is almost even on the day. This aversion to this recovery reflects the market’s fear of what the Fed has decided to do and what it will continue to do on future economic conditions. Investors have a strong interest in knowing how future policies can be expected to affect capital flows and what affect they will have on currency valuations.
Given the Fed’s historical role in dictating the course of monetary policy, it has inevitably been a key target of market participants. Even just signalling a shift in interest rate policy, as Fed officials do often, can cause rapid and massive volatility in the foreign exchange markets. This is especially the case for the US dollar.
The Global Currency Landscape
As the US Dollar continues to be the world’s main currency, so too does Washington’s mighty geopolitical power. This dominance determines many aspects of the international trade and financial landscape. Additionally, the enormous dollar-denominated transaction volume reflects its importance on global markets. With the US Dollar accounting for more than 88% of foreign exchange turnover, it is still the bedrock of global trade.
Most countries use the US Dollar in conjunction with their local currencies, making it an even stronger ‘de facto’ standard. Increased adoption drives increased trade and investment among countries. It leaves those economies prone to fluctuations in the value of the US Dollar.
The consequences of these trends are serious, particularly for those economies that are most reliant on exports. Countries such as Australia will need to repeatedly respond to the shifting nature of demand from China. This is increasingly critical in the face of volatile trade policies and tariffs.